An Overview Of The Specific Nature Of Internal Audit Accounting Essay


An introductory subdivision should supply an overview of the specific nature of internal audit. Briefly the construction and map of the Internal Audit Unit should be presented. The difference between internal audit and internal control should be discussed

It is good known that corporate administration is a critical portion of the corporate construction, and as an extension of that, internal audit increases the function of corporate administration and provides the houses with better relationships among their members. However, the inquiry that might originate is ‘What truly corporate administration is and what is the function of internal audit? ‘

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The definition of corporate administration has been recognised since 1970 and is defined in different ways ( Cattrysse, 2005 ) . One of them is ‘the mean to better dealingss between companies and their stockholders ; to better the quality of outside managers ; to promote people to believe long-run ; to guarantee that information demands of all stakeholders are met and to guarantee that executive direction is monitored decently in the involvement of stockholders. ‘ ( Cattrysse, 2005, pp. 3 ) . Corporate administration includes members such as board of managers, direction, audit commission, and stakeholders ( Cattrysse, 2005 ) .

The function of internal audit within an administration is to guarantee that all internal processs and controls made by the direction are equal and effectual ( Cattrysse, 2005 ) . An internal hearer is hired by the direction and at the same clip the individual who occupies this place should be independent, something that is in contrast with the manner this enlisting occurred ( Cattrysse, 2005 ) . For that ground, the audit commission supports the position that there should be official mechanisms between the internal audit and the internal commission to procure the confidential exchanges ( Cattrysse, 2005 ) .

The construction of Internal Audit Unit can be met in three different ways ( Li, 2006 ) . Harmonizing to Li ( 2006 ) , the internal audit unit and the Board of Directors are at the same degree of authorization and the monitoring commission is steering the internal audit unit. The 2nd type of construction occurs when the internal audit unit and the company ‘s assorted sections are at the same degree and the former is controlled by the Board of Directors, whereas the 3rd type happens when the internal audit unit is integrated into the finance section since internal auditing is a critical portion of finance unit ( Li, 2006 ) .

Internal Audit Unit should back up the undermentioned maps in order its function to be utile in a company ‘s operation: mission and range of work, answerability, independency, duty, authorization, and criterions of audit pattern ( Fitzsimon, 2005 ) . However, a more elaborate presentation of Internal Audit Unit ‘s maps is traveling to be discussed into following subdivision.

Internal control and internal audit are two different significances and should non be confused ( Cattrysse, 2005 ) . The chief function of internal control is to supply the users with dependable, relevant, seasonableness, and conformity with Torahs and statute laws in the fiscal statements, so as to help the users in the determination devising procedure through information ‘s truth ( Cattrysse, 2005 ; KPMG, 2008 ) . Firms strive to understate their hazards of stuff misstatements which are occurred in the fiscal statements ( Cattrysse, 2005 ; KPMG, 2008 ) . On the other manus, internal audit is the activity that is executed by internal hearers to oversee whether the internal control system operates sufficient or non ( Cattrysse, 2005 ; KPMG, 2008 ) .

Internal Audit Unit, Audit Committee and External Auditor

The study should so analyze the grounds for presenting internal audit within the corporate construction. The duties and function of the Audit Committee should be analysed. The study should briefly describe and measure the functions of, and relationship between, the Internal Audit Unit, Audit Committee and External Auditor.

KPMG ( 2008 ) states that internal audit is a cardinal portion for a company. Board of managers can carry through their internal control undertaking, through the internal audit ‘s supervising and aid ( KPMG, 2008 ) . The grounds why an internal audit unit should be introduced in a corporate construction, as KPMG ( 2008 ) refers, are to be presented.

Internal audit a ) provides a brief description of the administration ‘s control type and evaluates the tone at the top, B ) demonstrates indifferent hazard appraisal, degree Celsius ) shows the assorted procedure signifiers of the administration, vitamin D ) explains the part of the assets, vitamin E ) releases valid information of frauds and misrepresentations, degree Fahrenheit ) illustrates reappraisals of unacceptable degrees of hazard, g ) displays the conformity model, H ) presents the operational and fiscal public presentation, I ) offers suggestions for better use of resources, J ) estimates the complete ends and aims, and K ) gives feedback about house ‘s codification of moralss and house ‘s values ( Hermanson & A ; Rittenberg, 2003 ; KPMG, 2008 ) .

Audit commission exists due to the fact that every administration should supply to the public dependable and accurate information and proper appraisal of the hazard of the house that are interested in. To be more precise, in conformity with NACD ( 2000a ) , Hermanson & A ; Rittenberg ( 2003 ) , and Sarens et al. , ( 2009 ) audit commission ‘s undertaking is chiefly to detect the fiscal coverage process, to oversee the internal control system, intending that hazards are calculated and minimised by the direction, and to supervise whether the internal and external hearers do their work decently or non. Others support the position that audit commission should underscore chiefly in the overseeing of fiscal coverage process ( Hermanson & A ; Rittenberg, 2003 ) .

As mentioned above, the monitoring of external hearers includes the fact that an audit commission in some states ( e.g. USA ) has the authorization to disregard external hearers from their responsibilities, to engage new 1s, and to measure their independency ( Hermanson & A ; Rittenberg, 2003 ) .

Fig. 1: Internal Auditing in an Organizational Governance Framework.

Beginning: Ruud & A ; Bodenmann, 2001, pp. 522 ; Ruud, 2003, pp. 75 )

Despite the fact that external hearers are non incorporated in the administration, they are considered to be engaged by it ( Pop et al. , 2008 ) . Additionally, they provide an one-year study of the administration ‘s fiscal statements. Furthermore, external hearers can understate mistakes that are non material significance and as an extension of the aforesaid, they focus on the general public presentation and fiscal consequences. Finally, they examine hazard factors sing direction issues and ‘behaviours ‘ ( Pop et al. , 2008 ) . Rudd ( 2003 ) claims that, an audit commission acts as a coordinator between external audit and internal audit unit. Figure 1 supports the old debate.

It so far obvious that internal auditing is influenced by senior direction and external auditing is non ( Pop et al. , 2008 ) . Goals and schemes of internal scrutinizing rely on the direction ‘s demands whereas external hearers are interested in accurate and indifferent fiscal statements that do non embrace stuff misstatements ( Pop et al. , 2008 ) . What is more, external auditing should be informed by the internal hearers in instance something unexpected happens to the internal auditing studies and external hearers should advise when an event is able to impact internal auditing ( Pop et al. , 2008 ) . External hearers must hold complete entree to internal auditing studies, and in conclusion, they should transport out an rating of the internal audit map ( Pop et al. , 2008 ) .

3.1. Interaction between the audit commission and the internal audit map: penetrations from old qualitative surveies

Recent qualitative surveies by Beasley et Al. ( 2009 ) , Gendron and BeI„dard ( 2006 ) and Gendron et Al. ( 2004 ) demonstrated

that patterns carried out in audit commission meetings aim to do members comfy, with respects to affairs such as

the truth of fiscal statements and the quality of the work performed by internal and external hearers. The consequences of

these surveies argue that the impression of comfort, as introduced in Pentland ‘s ( 1993 ) survey on audit battles, is a cardinal

facet of the work performed by audit commission members. For illustration, the survey by Gendron and BeI„dard ( 2006 ;

236 ) answers the inquiry: ”what actions do scrutinize commission members and other attendants engage in while seeking to extenuate

their anxiousnesss and transform them into hope and comfort zones? ”

Audit commission members at three Canadian public companies studied by Gendron et Al. ( 2004 ) had an involvement in the

extent to which internal control is effectual, non least because internal control underlies the credibleness of fiscal studies.

Audit commission members in their survey relied on the work of the internal audit map to develop their ain grasp

of the internal controls ‘ effectivity ( californium. besides Krishnan, 2005 ) . More specifically, they became comfy with internal

control by measuring the extent to which directors adopt appropriate steps to work out lacks highlighted in internal

audit studies. In all three of their instances, internal hearers attended audit commission meetings.

In add-on, a more recent survey by Gendron and BeI„dard ( 2006 ) , partly based upon the same information, found that audit

commission members carry out diverse patterns, in order to go comfy with their company ‘s internal controls, and

that several of these patterns deal with internal audit studies. Their interviewees confirmed that internal auditing mattered

to them. More specifically, the work of the internal audit map makes seeable the extent to which top directors are

competent at covering with hazard and internal control. It turns out, from their interviews, that internal hearers are cognizant of

their capacity to bring out jobs. The writers concluded, hence, that the internal audit map appears to play a cardinal

function in the development of an answerability relationship between corporate direction and the audit commission, which

refers to the principal/agent job between the audit commission and direction, as described earlier in this paper.

Beasley et Al. ( 2009 ) , analyzing the audit commission inadvertence procedure within 42 US public companies, found that audit

commission members clearly are dependent upon both internal and external hearers in measuring the effectivity of

internal control over fiscal coverage. In general, the audit commissions in their survey would run into often with the

internal hearers. It appeared that the audit commission ‘s interaction with internal hearers had increased from pre-SOX

periods, but remained really limited in some of their instances. However, their interviews revealed frequent, on-going substantive

communications between the audit commission and internal hearers outside of scheduled meetings. In many of their instances,

the inadvertence of the internal audit map was shared between the audit commission and direction in a reasonably informal,

sometimes combative mode. The research workers besides identified a significant deficiency of lucidity in the internal audit map ‘s

coverage channels.

Additionally, a recent instance survey conducted at a UK listed fiscal services company by Turley and Zaman ( 2007 ) revealed

that, when judged utilizing formal procedures entirely, the direct impact of the audit commission on affairs of internal control and

audit is limited. The writers found merely limited grounds of the audit commission oppugning or disputing internal audit

findings. Furthermore, the influence of the audit commission on the docket and work program of the internal audit map turns out

to be limited. The primary active concern of the audit commission, with regard to internal control, appears to be to guarantee that

the internal audit program is met. Members argue that their limited function in specific internal control affairs may be explained by

the audit commission ‘s deficiency of elaborate cognition, thereby implicitly mentioning to the information dissymmetry job with

which audit commission members must cover. However, the writers found grounds back uping the importance of an informal

channel of communicating between the caput of the internal audit map and the audit commission chair, through which

concerns might be raised. In their specific instance, the caput of the internal audit map considered that describing concerns to

the audit commission by and large led to improved administration, which confirms the importance of the relationship between the

audit commission and the internal audit map.

It must be noted that the above-named surveies implicitly assume a principal/agent job between the audit

commission and direction, taking to important information dissymmetries on behalf of audit commission members.

Furthermore, these surveies recognised the internal audit map as an of import mechanism by which to cut down these

information dissymmetries, without lucubrating on what makes it so. The current survey will lucubrate more on the particular

information dissymmetries that exist, on behalf of the audit commission, thereby further researching the impression of comfort within

the specific context of the audit commission procedure. Additionally, this survey will integrate an probe into what makes

the internal audit map a suited comfort supplier for the audit commission. ( sarens et Al, 2009 )

Internal audit and corporate administration

The study should analyze and measure whether internal audit is able to better corporate administration. You should mention to official studies such as the Cadbury, Hampel and Higgs Reports, besides Sarbanes Oxley every bit good as the Combined Code 2010, as appropriate.

Internal audit ‘s work, through their ability to supply information to hazard ‘s decrease, can take a corporation into safety waies and therefore to better corporate administration ( Allen, 2008 ) . Consistent with Allen ( 2008 ) , internal auditing facilitates the map of ‘risk intelligent endeavor ‘ , connoting that these endeavors assess the chances and use scenarios in their operations, which enables them to the decision-making procedure and create schemes. The part of internal hearers at this point is to accomplish a solution for the corporation in order to be more hazard intelligent ( Allen, 2008 ) . Furthermore, they can move as an information channel every bit good as to heighten operating efficiency ( Allen, 2008 ) .

Hazard is another factor an endeavor should see since internal hearers can recognize the different types of hazard and instabilities that may happen ( Allen, 2008 ) . Enterprises can non boom when executing so as to avoid hazards ( Allen, 2008 ) . Alternatively, enterprises that utilise the internal hearers ‘ cognition could add new value in the administration and develop competitory advantage ( Allen, 2008 ) .

Most endeavors assume merely traditional fiscal measurings can measure their status but non-financial factors ( among others client satisfaction, operational quality, invention, and employee committedness ) are those indexs that can measure the public presentation of an endeavor every bit good ( Allen, 2008 ) . Ethical motives is besides a important factor, which can be recognised by internal hearers and raise the corporate public presentation by hiking the consumers ‘ assurance and making dedicated clients ( Allen, 2008 ) . Using their abilities and the fact that they are integrated in the company, internal hearers can construct value by informing direction trade with a figure of possible menaces, from corporate repute to environmental issues ( Allen, 2008 ) . Last, spread outing the board with members holding internal scrutinizing experience, higher council chamber diverseness could be achieved, and as a consequence, greater thought production and improved corporate administration could happen ( Allen, 2008 ) .

Cadbury Report ( 1992 ) , named as ‘The Financial Aspects of Corporate Governance ‘ provided recommendations for the reformation of boards and accounting systems so as to understate corporate administration hazards, and to set up effectual audit commissions with efficient internal controls. Cadbury ‘s recommendations focused on the separation of the functions between the president and the CEO ( Cadbury, 1992 ; Cattrysse, 2005 ) . Additionally, the thought that there should be an component in the council chamber, that could forestall CEOs from acquiring excessively much power, prevailed ( Cadbury, 1992 ; Cattrysse, 2005 ) .

In short, Cadbury refers to a model including three rules: openness, unity, and answerability ( Cadbury, 1992 ; Cattrysse, 2005 ) . A demand that could act upon internal audit map was the fact that the managers had to describe whether the internal control system was effectual or non ( Cadbury, 1992 ; Cattrysse, 2005 ) . The Cadbury Report is, in a great extent, based on the Committee of Sponsoring Organisations of the Treadway Commission ( COSO ) and Cadbury ‘s rules are applied in assorted world-wide corporations ( Cattrysse, 2005 ) .

Corporate dirts, such as Enron, Barings Bank, Northern Rock, and WorldCom, which cost one million millions to the investors, forced US to print the Sarbanes-Oxley Act of 2002 ( Cattrysse, 2005 ) . Section 404 in Sarbanes-Oxley Act ( SOX ) refers to the appraisal of internal control ( Sarbanes-Oxley Act, 2002 ) . Precisely, direction and external auditing should carry on a study refering the adequateness of internal control system for fiscal coverage ( Sarbanes-Oxley Act, 2002 ) . SOX presented eight sets of ‘rules ‘ or ‘codes ‘ until 2004 taking to reconstruct the repute of the biggest US administrations and to heighten good corporate administration ( Cattrysse, 2005 ) . Furthermore, an internal auditing became a necessity for all NYSE listed companies ( Cattrysse, 2005 ) . Nevertheless, even with these rough steps, SOX did non pull off to eliminate the hazard of corporate dirts ( Cattrysse, 2005 ) .

The Combined Code 2010 formulated due to Hampel Committee and promoted even more good corporate administration ( Combined Code, 2010 ) . The Combined Code combines the elements of answerability and corporation prosperity ( Combined Code, 2010 ) . The former component was the corner rock of the Code since it could better the public presentation and the net income of the house ( Combined Code, 2010 ) . The recommendations of Cadbury Committee, Greenbury Committee, and Hampel Committee compose the Code which references among others that the audit commission should be represented by independent non-executive managers and great accent has been given in the impression of unity due to the aforesaid corporate dirts ( Cattrysse, 2005 ) .

Corporate dirts

The study should besides mention to recent corporate dirts such as Enron, Barings Bank, Northern Rock, WorldCom, Lehman Brothers and Satyam Computers every bit good as the current fiscal crisis. It should measure the function of internal audit in these corporate dirts.

Lehman Brothers belongs to the most and biggest corporate dirts in history. The grounds of the bankruptcy are rather clear. Several executive members were highly-paid despite the fiscal crisis. This fact revealed that the proportion of the payments was far excessively immense in relation to the old twelvemonth ‘s payments. Another ground for the bankruptcy appears to be the unequal internal audit control since they let accounting system to be manipulated showing practical Numberss in the balance sheets. As Story & A ; Dash ( 2010 ) province, Lehman exploited a little house named ‘Hudson Castle ‘ to travel some of the assets and minutess in order to conceal the existent fiscal place of the company. Lehman could command the board members since he possessed a portion of the Hudson Castle.

Apart from the aforesaid grounds, Lehman Brothers suffered many losingss from the mortgages which had been already securitised. The bank had deficiency of liquidness because the borrowers were unable to pay their loans due to the crunch. The bank ‘s stock started to fall quickly and the bank released 1,500 employees to get by with its depts. Bank ‘s investors felt insecure and lost their religion, floating Dow Jones down. The company tried to do trade with Barclays, a big investing house in UK, so as to be sold but the trade collapsed. Government besides denied helping Lehman Brothers, ensuing to the bankruptcy filing. Harmonizing to Bloomberg, J.P. Morgan gave to Lehman Brothers a liquidness encouragement, money that were repaid by the Federal Reserve Bank of New York to J.P. Morgan two yearss subsequently. WIKIPEDIA

As it seems, the deliverance program for Lehman Brothers was absent because the bank was merely the victim since the aid could come before. The bank collapsed, dragging tonss of investing houses down. The Domino consequence that occurred forced authoritiess to redevelop bank ordinances in order to better counsel, transparence, revelation, and monitoring.

To better board inadvertence of fiscal minutess like Repo 105, it is more of import to alter the attack of corporate audit commissions than to heighten the information-sharing among accounting regulators. It appears that members of Lehman ‘s audit commission were non cognizant of the many repeats of the Repo 105 minutess. Their ignorance says a batch about what is incorrect with the current attack to the audit procedure in publically traded companies.

In conformity with the Sarbanes-Oxley Act of 2002 and related exchange regulations, all members of the Lehman audit commission were independent, and the commission ‘s chair was a fiscal expert. Following other regulations, the audit commission made certain that the company ‘s hearer ( Ernst & A ; Young ) was independent of Lehman, and met in private with the engagement spouse of the audit house without Lehman direction nowadays.

Under Sarbanes-Oxley and related Securities and Exchange Commission regulations, Ernst & A ; Young supplied the audit commission with a list of Lehman ‘s important accounting policies. Ernst & A ; Young was besides specifically obligated to describe to the audit commission any important dissension with direction on fiscal coverage. However, Ernst & A ; Young seemingly went along with Lehman ‘s accounting intervention of Repo 105. The audit house and Lehman relied in portion on a missive from UK advocate speak uping that Repo 105 constitutes a sale under UK jurisprudence.

In short, to rephrase Donald Rumsfeld, members of Lehman ‘s audit commission did non cognize what they did non cognize. Unfortunately, audit commissions are frequently in this province of nescient cloud nine. The commission members are deluged with monolithic sums of complex information, including elaborate fiscal statements and drawn-out SEC filings. It is highly hard for commission members, no affair how intelligent, to pick out from this mass of informations the key judgements made by direction and the external hearers in seting together these statements and filings.

To go more effectual, audit commissions should bespeak four specific pieces of information. First, the hearers should foreground any set of minutess – such as gross revenues or adoptions every bit good as off balance sheet and tax-motivated trades – which occur repeatedly at the terminal of quarters or fiscal old ages. It is rather sensible to plan one complex dealing in response to a alone set of fortunes ; it is more leery if similar minutess occur often near the terminal of a coverage period.

Second, the hearers should place any material point where the accounting literature allows alternate methods of presentation and explicate why the company believes its option is preferred. For illustration, the accounting literature allows, but non does non necessitate, companies to utilize hedge accounting in certain fortunes. Committee members should be to the full briefed on whether and why the company decided to utilize hedge accounting.

Third, and possibly most significantly, the hearers each twelvemonth should supply the audit commission with any material differences in important accounting policies between the company and its four or five chief rivals. This comparative analysis should cover policies such as gross acknowledgment, guarantee duties, retirement program duties, revenue enhancement militias and rating of good will or other intangibles. Some of the differences in accounting intervention will be due to differences in how the companies run their concerns ; others will stand for accounting judgements that the commission should to the full understand.

Finally, the company ‘s main fiscal officer should supply the audit commission with analyst studies discoursing the accounting methods embodied in the company ‘s financials or knocking the “ quality ” of its net incomes. Analysts are speedy to indicate out what they perceive as accounting catchs used by companies to better their grosss or net income. They typically try to acquire to a company ‘s nucleus net incomes by depriving off these catchs every bit good as non-recurring points, alterations in revenue enhancement rates and gains/losses from currency motions.

All these pieces of information should be sent to the audit commission at least one hebdomad before the commission meets. During that hebdomad, the president of the audit commission should informally discourse with the hearer ‘s engagement spouse any specific issues raised by this information and more by and large any “ close calls ” in the fiscal studies.

If adopted, these steps will assist scrutinize commissions place the cardinal judgements made by direction and the external hearers in fixing the company ‘s fiscal statements. Alternatively of seeking to happen a acerate leaf in a hayrick, commission members will be concentrating on the accounting issues most likely to falsify the accurate presentation of the company ‘s fiscal state of affairs.

current demands and duties of Internal Audit Unit

Based on recent statute law, the study should depict the current demands and duties of the Internal Audit Unit. It should explicate how the Internal Audit Unit interacts with the Audit Committee and External Auditor, and should besides research how the part of internal audit can be measured.


In drumhead, the study should analyze whether and how the debut of internal audit enhances companies ‘ effectivity and answerability. It should see which demands and maps are particularly helpful for companies and investors.


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